WHAT IS EMERGING MARKET DEBT?

Emerging market debt, or EMD, refers to debt issued by countries or by corporates based in countries that are defined as “emerging” based on certain widely accepted criteria, such as GDP per capita below a certain ceiling level. EMD consists of three main areas, which generally reflect whether the issuers are sovereign or corporate issuers and whether they are issuing in their own country’s currency (local currency) or in a foreign currency (hard currency or external currency), such as US dollars or euro.

HOW DOES MERCER CATEGORIZE EMERGING MARKET DEBT STRATEGIES?

As set out earlier in this paper, EMD comprises quite a number of areas and, accordingly, Mercer has several ways of looking at EMD mandates.

We have five EMD universes on MercerInsight:

EMD hard currency: strategies that invest solely or predominantly in hard-currency sovereign debt. Typically, the strategy tracks one of the JPM EMBI benchmarks or equivalent.

EMD local currency: strategies that invest solely or predominantly in local-currency sovereign debt. Typically, the strategy tracks one of the JPM GBI-EM benchmarks or equivalent.

EMD blend: strategies that invest in a mix of hard- and local currencysovereign debt. Typically, the strategy tracks a 50:50 blend of JPM EMBI:JPM GBI-EM benchmarks or equivalent.

EMD corporates: strategies that invest solely or predominantly in hard-currency EM corporate debt. Typically, the strategy tracks one of the JPM CEMBI benchmarks or equivalent.

EMD total return: strategies that invest across the EMD spectrum of markets (hard currency, local currency, corporate, etc.) in a benchmark-agnostic “go anywhere” manner. Managers would also be conscious of protecting returns against the downside. We do not expect these strategies to have a benchmark (although some managers may quote a reference benchmark, typically some combination of the main market indices). Relative to the strategy types above, total-return strategies are more reliant on manager skill (alpha) as a driver of return.

WHAT’S THE OUTLOOK FOR EMERGING MARKET DEBT?

We support the case for EMD exposure on the basis that it provides investors with access to a large and diversifying set of assets and return drivers with different characteristics to developed-world assets. An important aspect of EM growth dynamics is the possibility for significant productivity gains due to improvements in infrastructure, equipment and labor force up-skilling. Many EM economies are also exposed to demographic tailwinds driven by younger populations (relative to much of the developed world), which are expected to contribute positively to labor force and economic growth. From a debt perspective, a number of key emerging economies also enjoy lower levels of government debt and stronger fiscal positions than their developed-market counterparts.

On a nearer-term basis, our analysis is also broadly favorable for EMD markets, although we are conscious of the risks that are part and parcel of investing in EM economies, as well as being aware of the valuation outlook for EMD markets.

We continue to believe that EMD strategies can play a valuable role in investors’ growth portfolios going forward.